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COST VOLUME & PROFIT ANALYSIS

What is Cost - Volume - Profit (CVP) Analysis?

The cost-volume-profit model, often commonly referred to as a break-even analysis, aims to define
a break-even point for different sales levels and cost structures, which may be useful for managers
making short-term economic decisions. Cost-volume-profit (CVP) analysis is a cost accounting
approach that explores the effect of varying levels of cost and volume on operating profit. In simple
words, CVP analysis allows management to evaluate the relationship between expense and
revenue to generate profit.

The cost-volume-profit analysis makes many assumptions, including that the value of goods, fixed
costs, and variable costs per unit are constant. Running this analysis involves using several values,
cost, and other factor formulas, and then plotting them on the economic map.

The following document highlights various aspects of CVP analysis which are as follows -

1. Approaches to Calculate CVP:

1.1 Equation Method:
1.2 The Contribution Method:
1.3 The Graphical Method:

2. What Does Cost-Volume-Profit Analysis Tell You?

3. Benefits of Cost - Volume - Profit Analysis
4. Limitations of Cost - Volume - Profit Analysis

1. Approaches to Calculate CVP:

To calculate CVP, we usually follow three main approaches:

1.1 Equation Method:

Realization of the fact that the total revenues are estimated by multiplying the unit selling
price (USP) by the quantity sold (Q). In contrast, total costs are made up, firstly, of overall
fixed costs (FCs) and, secondly, of variable costs (VCs). Total variable costs are calculated
by dividing the unit variable value (UVC) by the total quantity (Q). Any excess of total
revenue over total cost would give rise to benefit (P). By putting this knowledge in a simple

MANAGEMENT ACCOUNTING COST - VOLUME - PROFIT ANALYSIS

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equation, we get to answer questions of the CVP. This is achieved below, following the
example of Company A above.

Total revenue – total variable costs – total fixed costs = Profit

(USP x Q) – (UVC x Q) – FC = P
(50Q) – (30Q) – 200,000 = P

Continuing our formula, we are now setting P to zero to figure out how many products we
need to sell to make any profit, i.e., break-even:

(50Q)–(30Q)–200,000=0
20Q–200,000=0
20Q= 200,000
Q= 10,000 units.

The formula has given us the answer. If Company A sells fewer than 10,000 units, there
will be a loss. If it sells exactly 10,000 units, it will break down, and if it sells more than
10,000 units, it will make a profit.

1.2 The Contribution Method:

This second approach uses a bit of algebra to rewrite our above equation, focusing on using
the' contribution margin.' The contribution margin is equal to the less total variable cost of
total revenue. The unit contribution margin (UCM) is, alternatively, the unit selling price
(USP) less than the unit variable cost (UVC). The formula of our above mathematical
method is therefore manipulated as follows:

(USP x Q)–(UVC x Q)–FC= P

(USP–UVC) x Q= FC + P
UCM x Q= FC+ P
Q= FC+ P / UCM

So if P= 0 (because we want to reach the break-even point), we'd only take our fixed costs.
The contribution margin of the unit is often referred to as the' contribution per unit.'

Use this method again for Company A:

UCM= 20, FC= 200,000, and P= 0.
Q= FC / UCM
Q= 200,000 / 20

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Ultimately, Q= 10,000 units

1.3 The Graphical Method:

Total costs and total revenue rows are plotted on a map with the graphical method; $ is
shown on the y-axis, and units are shown on the x-axis. The break-even point is the point
at which the total cost and sales rows converge. For different output levels, the amount of
profit or loss is measured by the difference between the total cost and the total revenue
columns. The figure below shows a typical Company A break-even chart. Variable
expenses are represented by the gap between the fixed costs and the total cost line.

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2. What Does Cost-Volume-Profit Analysis Tell You?

The contribution margin is used to calculate the break-even point of revenue. By dividing
the total fixed costs by the contribution margin ratio, the break-even point of revenue may
be measured in terms of total dollars. For example, a business with a fixed cost of INR
100,000 and a profit margin of 40% will earn revenue of INR 250,000 to make a break.

Profit may be added to the fixed costs to perform the CVP analysis at the desired outcome.
For example, if the previous company wanted an accounting profit of INR 50,000, the total
sales revenue is determined by dividing INR 150,000 (the sum of the fixed costs and the
desired profit) by a contribution margin of 40%. This example generates the necessary sales
revenue of INR 375,000.

CVP analysis is only effective if costs are set at the specified level of production. All units
produced are expected to be sold, and all fixed costs are expected to be constant in the CVP
Analysis. The hypothesis is that all increases in spending arise due to changes in the level
of activity. Semi-variable expenses must be split between the category of expenditure using
the high-low approach, the scatter plot, or the numerical regression.

3. Benefits of Cost - Volume - Profit Analysis:

1. CVP research provides a clear and concise view of the level of sales necessary for a
company to break even (no profit no loss), the level of sales needed to achieve the desired
gain.
2. Analysis of the CVP helps management understand the various costs at different levels of
volume of production/sales. CVP research helps decision-makers in expense and benefit
modeling related to volume transition.
3. CVP Analysis helps businesses evaluate the competitive consequences of closing down a
business or continuing to lose through recessionary periods, as it bifurcates the direct and
indirect costs explicitly.
4. The consequences of improvements in fixed and variable costs help control the optimal
level.

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4. Limitations of Cost - Volume - Profit Analysis:

1. Analysis of the CVP assumes that fixed costs are constant, which is not always the case; it
also changes beyond some level of fixed costs.
2. Variable costs are assumed to vary in proportion to what is not happening.
3. Evaluation of Cost Volume Profit implies that costs are either static or variable; however,
certain costs are, in essence, semi-fixed. Telephone charges, for example, consists of a
fixed monthly fee and a variable charge based on the number of calls made.

MANAGEMENT ACCOUNTING COST - VOLUME - PROFIT ANALYSIS